Introduction

Stablecoins have become one of the most significant breakthroughs in the cryptocurrency industry. Since its initial issuance in 2014, USD-pegged stablecoins, in particular, have seen massive adoption, with their supply reaching USD $153 billion as of July 2022.

These stablecoins were thought to be the gateway to mass cryptocurrency adoption as it offers a stable store of value compared to more volatile assets such as BTC. The downside however is that it functions almost entirely like fiat due to its centralized control system and vulnerability to inflation. Even though fiat-backed, centralized stablecoins like USDC, USDT, and BUSD have been the most popular, other types of stablecoins promising to solve these inadequacies have also risen in prominence.

The main alternative to the fiat-backed stablecoins are crypto-backed stablecoins . These stablecoins typically utilize a unique combination of behavioral economics, smart contracts and carefully designed algorithms to maintain the peg to fiat currencies without the control of a centralized custodian. To varying extents, crypto-backed stablecoins offer far more capital efficiency and decentralization than fiat-based stablecoins. These projects also usually incorporate some form of financial incentives, promising an asset class of digital currency that is not just decentralized and stable, but also potentially lucrative.

Unfortunately, the extent of financial rewards can sometimes act as a double-edged sword, as there is also increased risk borne by the user. An example of this would be UST, which leveraged on an under-collateralized model and a burn-and-mint algorithm to maintain its peg while promising attractive liquid staking yields.

Despite the substantial amount of promises and solutions that stablecoins promise to bring, the market still lacks a clearly defined leader. A fine balance between risk, reward and stability must be achieved to not just drive mass consumer adoption, but also long-term sustainability.